Here is the scoop on corporate tax reform proposals from House Republicans

The corporate tax is ripe for reform. The Republican tax reform proposal is an excellent way to kick-start the needed discussion.

Republicans in the House are proposing sweeping corporate tax reform. Their proposals would effectively repeal the corporate income tax, currently levied at a 35 percent rate, and replace it with a new “destination-based cash-flow tax (DBCFT)” at a 20 percent rate for corporations and 25 percent for unincorporated businesses.  The new tax would be border-adjustable – taxing imports and exempting exports.

The DBCFT has a lot to offer and it deserves a serious look.  But right now, the overall proposal is very poorly understood.  Here are 11 things to know: 

(1) The truly radical part is the proposal to effectively abolish the corporate income tax.  The United States would become the only advanced country without a corporate income tax, making it a very attractive location for international investors.  

(2) The DBCFT is essentially a value-added tax (VAT), but with a deduction for wages.  Every advanced country except the U.S. has a VAT alongside a corporate income tax.  The U.S. would in effect be replacing the corporate income tax with a modified VAT.  A VAT taxes consumption, not income – it has the same effects as a national retail sales tax, but works better administratively. 

(3) Unlike the corporate income tax, the DBCFT would not distort investment or financing choices.  Instead, it would eliminate taxes on the returns to investment and would treat debt and equity equally.  It would also eliminate all transfer-pricing issues and incentives to shift profits and profitable activities offshore.

(4) However, precisely because the DBCFT does not have the negative incentive effects of the corporate income tax, there is no good reason to reduce the tax rate to 25/20 percent.  Indeed, the tax rate should be equal to the top rate on individual income, so as to reduce incentives to reclassify wage income as business income. 

(5) Border adjustment of a VAT is not some wild, radical idea.  It is a natural and logical part of the tax.  All advanced countries with VATs employ border adjustments.  In order to focus the tax on domestic consumption, the VAT should exempt exports – which are consumed abroad – and tax imports – which are consumed here.  Again, exactly like a retail sales tax.

(6) Many economists – but very few non-economists – believe that the international trade effects of border adjustments will be small.  In this view, taxing all imports and exempting all exports will raise the value of the dollar relative to other currencies.  To a first approximation, this will leave the level of imports and exports the same under the DBCFT as they would have been without the tax.  Border adjustments alone should not be expected to change the trade balance.  For all of the reasons, there should no expectation that the domestic price level will change.

(7) The deduction for wages makes the DBCFT progressive, relative to a VAT.  It only taxes consumption financed out of holdings of capital, whereas a VAT burdens all consumption.  The new tax would also plausibly be more progressive than the current corporate income tax, because it would not discourage domestic investment.  The investment disincentives in the current corporate tax reduce capital per worker and hence reduce wages.

(8) One potentially thorny issue is that the DBCFT may create negative net tax liability for some very big, very profitable exporters.  The DBCFT will only work as intended if those exporters get full rebates, even if that means Treasury has to write them a check.  This is likely to create a serious “optics” problem, given that many people think that big, profitable corporations should be required to pay taxes.  Likewise, the DBCFT will raise tax payments for importers.  These are all perception issues, however; the border adjustment won’t affect the after-tax profitability of either exporters or importers, because of the exchange rate adjustment.\

(9) A second issue is that border adjustment and the resulting exchange rate appreciation will reduce the value of American investments overseas.

(10) Another downside is that the World Trade Organization (WTO) allows border adjustments for VATs but not for income taxes.  The wage deduction makes the DBCFT look like an income tax (wages are deductible, for example, under the corporate income tax).  Many experts believe this would make the DBCFT, as currently proposed, incompatible with WTO rules.  If that were the case, either: a new deduction or credit for wages could be created elsewhere in the tax system; the wage deduction could be dropped, making the DBCFT revert to a VAT (which would make it more regressive); or the border adjustment could be dropped, which would reintroduce incentives for firms to shift profits and productive activities abroad. 

(11) A final concern is that the corporate reform proposals described above, even when coupled with some specified corporate tax revenue-raisers, would reduce federal tax revenue by about $900 billion over the next 10 years on a static basis.  Revenues would fall by somewhat less if the changes were dynamically scored, but the proposals would still represent a very large tax cut and would raise the public debt. 

Rough estimates suggest that setting the DBCFT rate at around 30 percent for all businesses would eliminate the revenue shortfall.  This would still leave it lower than the current corporate rate or the top individual tax rate, and suggests that an even higher DBFCT rate, coupled with a reduction in the top individual income tax rate, could equate the top individual and business rates and still be revenue-neutral and probably fairly close to distributionally-neutral. 

The corporate tax is ripe for reform. The DBFCT is an excellent way to kick-start the needed discussion.

This story originally appeared on TaxVox.